Pawlina, G and Kort, Peter M (2005) Investment under uncertainty and policy change. Journal of Economic Dynamics and Control, 29 (7). pp. 1193-1209. ISSN 0165-1889
Abstract
In this paper the impact of a policy change on the investment behavior of the firm is studied in an incomplete information setting. The policy change occurs when a stochastic process describing the state of the economic environment reaches a certain trigger. The firm has incomplete information about the trigger and knows only its probability distribution. Consequently, both the firm's conjecture concerning the trigger value as well as the precision of this conjecture serve as input parameters. We derive the optimal investment rule maximizing the value of the firm and show that the impact of the trigger value uncertainty on the optimal investment threshold is non-monotonic: the threshold decreases with uncertainty for its low levels, while the reverse is true if uncertainty is high. Furthermore, we provide results concerning the valuation of the firm's investment opportunity and present some policy implications.